No wonder Applied Materials and its Wall Street fans are waiting for the sun. Out of the semiconductor gloom, Applied shares (ticker: AMAT) have risen about 8% this year -- far outperforming Nasdaq, which has lost 14% -- to reach a recent $19. Meanwhile, analysts like Citigroup's Tim Arcuri are talking up the company's SunFab offering, a line of equipment for making huge solar-power panels, two meters to a side.

Wall Street is polarized over SunFab's prospects. Among hedge funds, the bulls at Tudor Investment have bet steak dinners, and loads of money, against the bears at Citadel Investment. The buyside bulls say that Applied's solar play should zap the stock to 60; the bears consider SunFab an unproven science project, with the rest of Applied's businesses worth just 14 a share. On the sell side, bulls such as Citi's Arcuri see SunFab sending Applied shares to 26, the bearish Covello tells his Goldman customers to sell Applied and buy First Solar. We'd suggest steering clear of the stock until there are some results to analyze.

What no one disputes is that the evidence on SunFab's value is scant. Applied's first few customers won't try production until this summer. No one's demonstrated techniques for installing the giant panels. By contrast, First Solar has been monitoring thousands of solar panels in the real world for over five years.

Solar panels made with Applied Materials' equipment would be bigger than others'. But better?

Applied is a profitable, cash-rich company, but Wall Street has to wait until its SunFab customers make and sell something, before concluding that Applied is a great solar company.

The really big picture is clear: We need solar power. Fossil fuels are warming the globe, raising the risk of mass extinctions and floods, while costs keeps rising.

The sun is a clean-energy source we can't exhaust. Worldwide installation of solar capacity exceeded 2.8 gigawatts (or billions of watts) in 2007, according to consultants at Solarbuzz (www.solarbuzz.com), up from 1.7 gigawatts in 2006. As Wall Street knows, this demand lifted the shares of solar-cell companies an average of 300% last year.

BUT THE COST PER WATT for solar panels is still well above the market-pricing of today's electrical grids that are powered mostly by oil, coal and gas. In the U.S., electricity averages around nine cents a kilowatt-hour (that is, an hour's supply of a thousand watts). Solar cells are inexpensive to operate, so the cost of their power is a function of the system price per watt: The cheapest solar-panel systems cost at least $4 or $5 per watt of generating capacity, including financing and installation.

Solar-cell manufacturers are working to bring down system costs to the point where they can produce electricity at market rates. Firms like SunPower and Suntech have labored to increase the efficiency with which their cells' silicon wafers convert sunlight to electricity, with SunPower achieving a better than 22% conversion rate. But a shortage of the raw polysilicon that goes into solar wafers has limited production, as it pinches margins.

That pinch helped jump start an alternative technology from First Solar, a 10-year old company bankrolled by Wal-Mart's founding Walton family. First Solar doesn't use silicon crystals, employing instead another semiconductor called cadmium telluride that better absorbs sunlight. More importantly, the company puts down just a thin film of the material, which is just one-hundredth the thickness of a typical solar wafer. The resulting thin-film panels are much cheaper, even though they convert sunlight to electricity less efficiently than silicon wafers. Typical wafer cells average 15% efficiency. First Solar's efficiency has climbed from 7% to 10.5% over the last five years. But First Solar can produce its modules for less than $1.12 per watt and earn a 55% gross margin by selling them for $2.36 per watt. That compares with silicon-wafer-based solar modules at $3.70 per watt. Even after installation and other expenses, First Solar's clients can bring in a solar system at about four bucks a watt.

Those economics enabled First Solar to bring in $500 million in revenues last year, with profits of $160 million, or $2.03 a share. The stock price topped $275 last week, a handsome 54-times the five bucks a share that analysts predict for '09 earnings. But the company thinks it can get costs down to grid parity by 2012. It's shooting for module costs of 70 cents a watt and total costs under $2 -- by raising conversion efficiency to 12% and producing in Malaysia.

Even Applied Materials' Chief Technology Officer Mark Pinto tips his hat to First Solar: "They created this market that the existing solar guys did not recognize."

The Bottom Line

Rather than betting on Applied Materials' untested solar-panel business, investors should await evidence that those panels can perform like First Solar's.

Applied Materials began putting together a thin-film solar production line last year, with some acquisitions and redesigns of the machinery it supplies to flat-panel display makers. Applied's SunFab gear lays down a thin layer of silicon, instead of the cadmium telluride used by First Solar. The resulting panels are less efficient, converting just 6% of light to electricity. But Pinto says the company has built panels with two layers of silicon that lift efficiency to 8%. Lab samples have hit 9.3%, he says, and he's confident of reaching 10% by 2010.

But the main way that Applied plans to be cost-competitive is by going wide...really wide. SunFab will make 5.7 meter-square solar panels -- that's six times the size of First Solar's. Pinto says installers tell him that savings from the big panels would be at least 17%, compared to silicon-wafer panels.

By way of illustration (see chart below), a SunFab panel might cost only 60 cents a watt for parts and installation, compared with 70 cents a watt for wafer-based panels and about $1 a watt for First Solar panels. (Our rough comparisons are based on First Solar investor presentations.) Pinto says SunFab could make modules as cheaply as 80 cents a watt in large-scale factories that churn out a gigawatt's worth of panels in a year.

Yet this pretty picture is theoretical. Pinto acknowledges that the installation machinery to handle SunFab's huge panels, and to get the 17% cost advantage, doesn't exist. Right now, he says, installation is "a guy with a pickup truck and a ladder."

First Solar wouldn't comment on SunFab economics, other than to say they were compiled from hypotheticals. Other prospective rivals include Switzerland's Oerlikon (OERL.Switz), which is offering thin-film-silicon production systems to make 1.4-meter-square panels and argues that Applied's huge glass plates will cost more to install. Solar-market leader Sharp chose to make thin-film panels of a 1.7-meter-square size, in a joint venture with Tokyo Electron, although it uses the larger 5.7-meter-square machinery in its flat-panel production.

SunFab panels would seem best suited for industrial and utility-scale installations. But it will have to compete for those against First Solar, as well as solar-thermal technology. Thermal technology uses mirrors to concentrate sunlight and boil water into turbine-powering steam.

Meanwhile, no Applied customer has run a production line. Wall Street's SunFab confab pushed the stock near 22 last month, as the company announced a letter of intent for a $2 billion gigawatt-scale factory from unnamed customers in Asia. As order announcements lifted the stock, Goldman analyst Covello was reminded of the dot-com bubble, when telecom-equipment stocks leapt on orders that ultimately weren't funded. That's when he put out a Sell.

Last Monday, Satya Kumar at Credit Suisse dropped his Applied rating to Neutral, saying that its core semiconductor and panel businesses were worth less than $13 a share, based on potential earnings of less than $1 a share. The same day, Citi's Arcuri pulled the stock from his firm's Top Picks list. He's maintaining his Street-high forecast of $1.84 in October 2010 earnings, but expects no evidence of SunFab's success before this June. "We're in the show-me phase," he says.